Interest relief: a question of relief

The UK has long been lauded as one of the more lucrative places for
corporates to do business because of the interest relief it offers to listed
companies.

This is despite long and intense criticism from unions and politicians who
believe businesses are abusing the rules by loading themselves with debt in
order to avoid tax.

However, signs are emerging that times are changing, and not necessarily for
the better. This is partly to do with pressure at home, but more to do with
pressure from abroad. UK business began to feel prickly about whether its
comfort zone could be sustained after a series of decisions by the European
Court of Justice that suggest the UK has too lax a tax environment, harbours
abuses outlawed elsewhere, and is not sufficiently harmonized with the rest of
Europe.

Joy Svasti-Falee, Grant Thornton’s head of international tax, says HM Revenue
& Customs announced it would conduct a review of interest relief because it
was concerned that Europe might rule that the UK’s current tax system simply
didn’t comply with European law and would have to change.

‘The hope of business is that the review will lead to amore simple and
competitive tax system which encourages holding companies to settle in the UK,’
Svasti-Falee says.

The review comes at a time when the UK, she says, appears to ‘have put up its
shutters’. She adds: ‘Ours is an onerous regime – not least because of complex,
controlled foreign company [CFC] legislation; a hefty clampdown on avoidance;
and a mainstream corporate tax rate, which, at 30%,compares unfavourably with
our neighbours. On the tax front, the UK hasn’t got much going for it and
seriously risks losing out on inward investment and employment opportunities.’

More recently, many UK plcs have articulated thoughts about quitting the
country for more tax-friendly climes.

Couple that with the increasing number of multinationals avoiding the UK for
similarly alternative locations, and you have the makings of a slippery downward
slope towards a regulation-heavy and burdensome no-go tax zone.

The government has so far been quiet on exactly what its review of interest
relief will actually consist of. Many are awaiting the consultative paper on the
review, promised at the time of the Pre-Budget Report, and set to consult
further on a number of proposed options for reform.

‘The consultation is now becoming urgent,’ says Svasti-Falee. ‘We had some
short-term changes to CFC rules announced in December. It’s very much a stop-gap
situation. We need to get a system sorted out.

‘It is very disappointing that we haven’t yet started the substantive
consultation. It needs to get going.’ In the meantime, economic secretary Ed
Balls recently commented on private equity deals, saying: ‘There is nothing
specific to private equity in the tax-deductibility of interest.

Any kind of company can claim it and most quoted companies do. It is also the
international norm – that interest is in general treated as a business expense
and deductible from taxable profits for companies in any form of ownership. We
have no plans to review this principle.’

Unfortunately, little comfort can be taken from this. What Balls did clarify
is that government is interested in the treatment of debt and equity, and, in
particular, in whether equity is being dressed up as debt for tax purposes to
cut company tax bills.

Svasti-Falee says that the fear with the review is that it could see the
introduction of restrictions, that would harm the international competitiveness
of the UK tax system.

‘The Revenue has said it will review taxation internationally and so also
look into anti-avoidance rules of CFCs and dividends,’ she says. ‘Overall, the
changes would have to be revenue-neutral, but it might mean that tax relief will
have to be restricted elsewhere.’

Gordon Brown’s budget hinted at the possibility of an exemption for dividends
and moving to an income-based system for foreign-controlled companies.

‘The worst case scenario will see the UK losing out on future inward
investment because we are slipping down the league tables for competitiveness,’
says Svasti-Falee.

‘The best outcome will be for us to get a genuinely simpler and less
burdensome tax system which will help make the UK more competitive and
attractive for investment.’

The review of interest relief offers some chance of dialogue and perhaps an
opportunity for government to provide some much needed reassurance to the
corporates. But dialogue is critical as huge amounts of business – and tax
revenue – is at stake.